Moody’s has raised its outlook for Vietnam’s banking sector from “Negative” to “Stable”, reflecting increased stability in the operating environment for banks, lower liquidity stress and a better macroeconomic situation in the country. Its decision is made based on five factors: operating environment (stable), State capital and liquidity level (improving), asset and capital quality (declining), profitability and performance (declining), and support system (stable).

“Improvements in macroeconomic stability have led to strengthened systemic liquidity,” said Mr. Gene Fang, Moody’s Vice President and Senior Credit Officer. “Deposit growth has recently improved, driven by government policies targeted at reducing gold and foreign currency deposits. At the same time, banks have lowered their reliance on interbank funding, which had exacerbated systemic liquidity risks, because the very high levels of interbank borrowing meant that a liquidity squeeze at any one bank could spread quickly to other banks.”

The report indicates that the operating environment in Vietnam has begun to stabilize after weakening in 2012 due to rapid credit growth. Inflation and interest rates in the country have declined steadily over the last two years from double digit levels. Pressure on the exchange rate has also eased. Higher levels of foreign direct investment, a shift in the current account balance to surplus from deficit, and a policy preference for stability over growth have all contributed to the improved conditions.

Moody’s report also points out that loan growth has slowed despite lower interest rates, as the increase in export activity has not entirely offset the fall in domestic demand. As a result, liquidity in the banking system has improved, as deposit growth has outpaced loan growth, lowering loan-to-deposit ratios.

The report also indicates that recent improvements in management standards have strengthened the recovery prospect for banks, but credit problems may cause the recovery to be slow.

In addition, banks’ loan loss reserves and capital are insufficient to absorb potential losses on problem assets. Options for capital raising are limited due to banks’ low ability to generate capital, the State budget being inadequate, and restrictions on foreign investment in banks.

As for profitability, Moody’s says the banks’ profitability profiles will continue to be under pressure, given the low demand for new loans, and average net interest margins will likely fall. Profitability can be improved if real estate prices rebound or if the retail sector can generate greater demand for loans.

Moody’s rated nine banks in Vietnam in its report, including BIDV, Sacombank, SHB, Vietinbank, VIB, VPBank, and Techcombank. As at June 30, 2014 these banks accounted for 40 per cent of the banking system’s total assets. Their weighted average baseline credit assessment is caa1, while their average standalone bank financial strength rating is E.

Vietnam’s efforts to overhaul its financial system and emphasize economic stability over growth has resulted in credit rating upgrades that enabled it to sell US dollar bonds overseas in November; the first time in almost five years. Government officials last week said the economy is expected to grow 5.9 per cent this year, above the World Bank’s estimate of 5.6 per cent.